Extraction Oil & Gas, Inc. (XOG) Q4 2018 Earnings Conference Call Transcript

XOG earnings call for the period ending December 31, 2018.

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Extraction Oil & Gas, Inc.  (NASDAQ:XOG)
Q4 2018 Earnings Conference Call
Feb. 21, 2019, 4:30 p.m. ET

Contents:

Prepared Remarks:

Operator

Good afternoon. I'm Liz, and I will be your conference facilitator today. I would like to welcome everyone to the Extraction Oil & Gas Fourth Quarter 2018 Financial and Operating Results Conference Call. (Operator Instructions)

Please be advised that the remarks today, including answers to your questions, include statements that the Company believes to be forward-looking statements within the meaning of the Private Securities Litigation Reform Act.

These forward-looking statements are subject to risks and uncertainties that could cause actual results to be materially different from those currently anticipated. Those risks include, among others, matters that the Company described in its financial and operating results news release issued this afternoon and its filings with the Securities and Exchange Commission. Extraction disclaims any obligation to update these forward-looking statements.

While the Company believes these forward-looking statements are reasonable, they are subject to factors such as commodity prices, competition, technology and environmental and regulatory compliance. Company's drilling schedules, capital plans and other factors may cause its results to differ materially.

I would now like to turn the call over to Louis Baltimore, Extraction's Director of Investor Relations.

Louis Baltimore -- Director of Investor Relations

Thank you, and good afternoon to everyone. We're glad you could join us today for our fourth quarter earnings call. With us today on the call, we have Mark Erickson, our Chairman and CEO; Matt Owens, the Company's President; Rusty Kelley, our CFO; Tom Brock, our Chief Accounting Officer; and Eric Jacobsen, our SVP of Operations.

I'd like to remind you that today's call, in addition to the aforementioned forward-looking statements, also includes a discussion of certain non-GAAP financial measures. Please be sure to read our full disclosure on forward-looking statements and GAAP reconciliations in our earnings release and in our filing on Form 10-K, which we provided earlier today after the close of trading.

I'll now turn the call over to Mark Erickson, our CEO, to go through some of the highlights for this quarter.

Mark Erickson -- Chairman and Chief Executive Officer

Thanks, Louis. Good afternoon, everyone. Welcome to our fourth quarter earnings call. First, I would like to recap some of our achievements our team made last year, which culminated in both our crude oil and total equivalent volumes exceeding the high-end of our guidance range, while our CapEx also came in at the low-end of our guidance. As a result of higher volumes and our continued focus on maintaining a low cost structure, all of our expense items also came in below the low-end of our guidance ranges for the year.

Looking at the fourth quarter specifically, we grew our crude oil production 18% sequentially, while generating over $37 million of free cash flow at the upstream level. When we talk about free cash flow, we are talking about our cash flow from operations minus our capital expenditures. We remain focused on capital efficient production growth, while operating inside of cash flow, which we view as a key element for a sustainable E&P business model.

We closed on about $165 million of asset sales during 2018, which more than offset the $116 million we incurred during the year for land and other. Our strategy of offsetting land and other capital with divestitures of non-strategic assets remains ongoing with another $22 million divestiture expected to close in the first quarter. Despite the perception of regulatory risk in the public markets, the A&D market in the DJ Basin remains active with both large and small operators recognizing the attractiveness of the basin.

With respect to operations, we brought online terrific wells, while focusing on maximizing our oil production during this period of tightness on the midstream side, which is evidenced by the strong production numbers we have delivered. From a safety standpoint, our operations team continues to lead by example, setting another new milestone of over 1.3 million man-hours without a single recordable employee incident. We continue to be recognized by the State of Colorado with awards and accolades for our efforts to go beyond compliance with state and federal regulations.

Our commitment to continue environmental improvement and demonstrated leadership in partnering with local communities. Our development activity is fully under way in Southwest Wattenberg, including Broomfield, and continues progressing as planned. We currently have a rig running in the area and expect continuous development through 2020 with robust production expected in the second half of 2019. Elevations gathering system is being built out and expected to be operational later in the year, concurrent with our development activities.

Last year, we announced strong initial production results from our Coyote Trails Pad located within our Broomfield development area. After being online for more than 150 days, these wells continue to deliver impressive production rates from both the Codell and Niobrara formations and are still exceeding our high expectations as you can see in our updated presentation.

Additionally, we recently entered into an agreement with Rocky Mountain midstream, the previously announced joint venture with KKR and Williams. They are currently building a gather in line for us up to our Greeley area, which gives us more flexibility and optionality going forward. We expect this line to be operational sometime in the fourth quarter this year, enabling us to finish the year strong as we go into 2020.

Turning to our 2019 guidance, our goal is to balance near-term cash flow neutrality without sacrificing investment in our longer lead time projects that will positively impact our production in 2020 and beyond. Specifically, we are targeting our capital expenditures to be fully funded (technical difficulty) at $50 WTI, excluding Elevation capital which is fully funded externally at the subsidiary level, but the common stock is wholly owned by Extraction.

We continue to expect our land and other capital to be offset with our ongoing asset divestiture program. As we think about this year in more detail, our production guidance represents low double-digit annual production growth, while also generating stronger levels of growth when comparing 4Q '19 to 4Q '18. This becomes even more impressive when taking into consideration the high bar that our very strong 4Q '18 set for us.

As our volumes continue to grow, we expect to see nice decreases (ph) in our per unit expense items, which should provide further support for our cash margins as we set our plan for a low to mid-50s crude oil environment.

I would like to thank everyone for your time on the call today. With that, operator, let's open the call up for Q&A.

Questions and Answers:

Operator

(Operator Instructions) Our first question comes from the line of Welles Fitzpatrick with SunTrust. Your line is now open.

Welles Fitzpatrick -- SunTrust -- Analyst

Hi, good afternoon.

Mark Erickson -- Chairman and Chief Executive Officer

Good afternoon.

Welles Fitzpatrick -- SunTrust -- Analyst

Great quarter and nice guidance, but to stick with what you were hitting on in the prepared comments, these Coyote wells doing almost 100,000 (ph) or I guess over 100,000 on the Codell side and just call it five months I mean, are those punching pound-for-pound or even better than Greeley at this point? I mean, these look like they compete with the Milkshake.

Mark Erickson -- Chairman and Chief Executive Officer

They're very strong wells. We're very pleased with them in the performance we've seen thus far. It really goes along with the geologic model that we had for the area down there. They are performing very in line in the first six months to what our Greeley wells normally do, but also keep in mind the wells that we've turned on in Greeley over the past 12 months or so have been also choked back fairly significantly.

Welles Fitzpatrick -- SunTrust -- Analyst

Yes, that's fair. And then can you remind us on the layout of these, I mean I know that they were at least founded on some sites, but can you remind us of the layout and also the mix of Codells and Nios on this first set?

Mark Erickson -- Chairman and Chief Executive Officer

Yeah. In that first set, we had 10 wells and we drilled pretty much the density that we're going to do an area, 16 to 18 wells per section. On that current, had -- we had -- there's three Codells that are producing there and the rest are Niobrara. And in the Niobrara, we have multiple wells in the A bench, B bench and C bench.

Welles Fitzpatrick -- SunTrust -- Analyst

Okay. And then just one last one, it looks like the location count jumped up a little bit, but no additional acreage was added. Is that just engineering some more locations or should we read anything into that?

Mark Erickson -- Chairman and Chief Executive Officer

There was a little bit of acreage added to the core just a few thousand acres and then a little bit of it was engineering as well.

Welles Fitzpatrick -- SunTrust -- Analyst

Okay, thanks so much.

Mark Erickson -- Chairman and Chief Executive Officer

Thanks.

Operator

Our next question comes from the line of Brad Heffern with RBC Capital Markets. Your line is now open.

Brad Heffern -- RBC Capital Markets -- Analyst

Hi, good morning everyone -- afternoon. I wonder if you could just talk a little bit about what led to the oil beat versus consensus, was it just stronger well performance, was it lower pressures than expected, any color on that?

Mark Erickson -- Chairman and Chief Executive Officer

I'd say it was a mixture of both of those. Obviously, the Coyote wells and some other newer wells that we brought online in different areas that weren't constrained where we were able to flow at more normal choke settings and exceed our oil targets.

Brad Heffern -- RBC Capital Markets -- Analyst

Okay. And then, I wonder if you could talk a little bit more about the Rocky Mountain Midstream deal, is that letting you bypass the DCP System when that ultimately comes online?

Mark Erickson -- Chairman and Chief Executive Officer

The Rocky Mountain system will be connected where we can offload from DCP onto that system as well as gather up wells that we have in the areas that are dedicated to the Rocky Mountain system.

Brad Heffern -- RBC Capital Markets -- Analyst

Okay. And do you have any numbers around what your capacity would be on that system?

Mark Erickson -- Chairman and Chief Executive Officer

On the Rocky Mountain system, it's initially been designed to handle 300 million cubic feet a day.

Brad Heffern -- RBC Capital Markets -- Analyst

Okay. And how much of that do you guys have?

Mark Erickson -- Chairman and Chief Executive Officer

Virtually 100%.

Brad Heffern -- RBC Capital Markets -- Analyst

Okay, great, thanks.

Operator

Our next question comes from the line of Paul Grigel with Macquarie. Your line is now open.

Paul Grigel -- Macquarie -- Analyst

Hi. Good afternoon. Just focusing maybe on the 2019 guidance. Can you just make the comment about D&C spending? How should we thinking about spending at Elevation realizing it is funded elsewhere, but is there any broad guidepost you could give for the spending there? And is there any other capital that we should be aware of that could be included within CapEx for '19?

Mark Erickson -- Chairman and Chief Executive Officer

Sure. As you know, Paul, the Elevation is wholly owned by Extraction shareholders. However, it is funded within unrestricted sub. So those -- the expenditures of Elevation, we do look at those kind of separate and apart from Extraction's upstream investment. When you look at kind of what our targeted investment we initially when we funded that project with up to $500 million that was funding which would cover both or cover our full south Wattenberg area. At this point in time, we're building out in the Southwest Wattenberg park, which represents about half of the total funding we are able to bring into the project.

Paul Grigel -- Macquarie -- Analyst

Okay. And what's the completion estimation on the southwest part of the project there?

Mark Erickson -- Chairman and Chief Executive Officer

It's going to be concurrent with our wells coming online and probably, I would say, sometime in the third quarter or early fourth quarter of 2019.

Paul Grigel -- Macquarie -- Analyst

Okay, that's helpful. And then, as you guys look at free cash flow usage and or asset sale proceeds that may come up throughout the year, how should we think about the use for the priority of that cash?

Mark Erickson -- Chairman and Chief Executive Officer

Sure. The first use of any asset sales will be used to offset any land and other type investment. I mean we always given our large acreage position we're always -- when we get ready to drill stuff, our average working interest is like 65%. So we're always making some small bolt-on acquisitions ahead of bad debt (ph) that fit very nicely from the standpoint of the lineup cash going out and creating cash flow coming in. That's really our first use. We use that to -- for our full end budget which is renewals, extensions, bolt-ons, small acquisitions, those types of projects. And in all, we've kind of looking at our budget, we're expecting that to be less than but kind of similar to what we had in 2018.

Paul Grigel -- Macquarie -- Analyst

And with the use of free cash flow that the business generates be toward that or be toward debt pay down?

Mark Erickson -- Chairman and Chief Executive Officer

Our free cash flow from the business is prioritized first to reduce debt and we're looking at a $50 price for WTI. So as we see incremental cash come in either from outperformance or higher commodity prices, we'd look to lower debt first and then additional maybe alongside of it other shareholder friendly means.

Paul Grigel -- Macquarie -- Analyst

Okay. And then one last one if I could. Overall, the expense guidance comes in pretty materially lower. Is there any certain initiatives you guys have undertaken on those that you could provide some color on to the drivers there?

Mark Erickson -- Chairman and Chief Executive Officer

Matt, you want to take that one?

Matt Owens -- Co-Founder and President

Yes. We spent a lot over the last couple of quarters focusing on getting our LOE down and I think that's really come through and then evident not only our numbers per BOE, but also on our absolute dollars. So we've had a really pretty successful program in lowering that our lease operating costs.

Paul Grigel -- Macquarie -- Analyst

Thanks.

Operator

Our next question comes from the line of Betty Jiang with Credit Suisse. Your line is now open.

Betty Jiang -- Credit Suisse -- Analyst

Hi. Can you talk about what drove the CapEx decline since the initial guidance and how much of the capital that's being spent this year is really benefiting 2020?

Mark Erickson -- Chairman and Chief Executive Officer

I'd say -- we kind of have the same working program that we normally do. So out of the wells that we're drilling in the end of the third quarter and fourth quarter will obviously be production that's going to be benefiting mostly in 2020. But as far as 2018 goes, we're continually innovating our completion designs and our drilling designs and we found some ways to save a little bit of money on frac designs in some areas and those haven't be a lot of the areas that we were completing wells in the year. So we were able to save some money and still get very good production results out of those wells in those areas.

Betty Jiang -- Credit Suisse -- Analyst

Thanks. And then could you give some color on where are the 2019 turning lines (ph) located, maybe a breakdown of the percentage that's going into DCP, Western and Rocky Mountain processing system?

Mark Erickson -- Chairman and Chief Executive Officer

Sure. When you look at our volumes that are on the DCP system, when you look at the curtailed volume specifically, you should note that we really don't need to complete any or till any new wells in the DCP in order to meet our allowables which we have on that system. And that would include even the turn on of Plant 11. So the bulk of our dollars will go into systems, other than DCP which could include Rocky Mountain or it could be Western Gas or Rimrock.

Betty Jiang -- Credit Suisse -- Analyst

That's helpful. And sir, just a follow-up on the earlier question on Rocky Mountain. What's the timing on that and would that result in any step change in production that's currently constrained as you move from DCP onto to the Rocky Mountain system?

Mark Erickson -- Chairman and Chief Executive Officer

Timing of that is probably sometime in the fourth quarter and we will have the ability -- the time of when they're turning that on, obviously, we will have some wells ready to turn in line at that point in time as well as incremental volumes, we will have the ability, at some point, I'm not quite sure it's going to be Q4 to offload volumes from DCP system that they are unable to take, but it does provide us with a tremendous amount of flexibility going forward. And that's going to allow us to take some of our very best inventory, which we have in our Greeley area and we're going to be hold up with under the current build out plans for the DCP system. It would take us several years to be able to develop those properties with the RMM system, we're going to be able to move those up into the queue (i.e) develop those on a much more accelerated pace. So we really like that from a capital efficiency standpoint, being able to take a bunch of our wells, which are in the top tier of our inventory and be able to move those up in our development plans.

Betty Jiang -- Credit Suisse -- Analyst

Great, thank you.

Operator

Our next question comes from the line of Gail Nicholson with Stephens. Your line is now open.

Gail Nicholson -- Stephens Inc -- Analyst

Good afternoon everyone. When you look at the 4Q '19 growth trajectory, it's a very, very nice growth over 4Q '18, when you think about that one to two rig program -- should we think that maybe there are more rigs in the back half of '19 or to the prepare for the 2020 and carrying that momentum forward? I'm just trying to conceptualize that preparation aspect.

Mark Erickson -- Chairman and Chief Executive Officer

Sure. If you note in our remarks that we've made, we basically said that we expect Q1 and into Q2 kind of be -- kind of flat to slightly down and as volumes pick up from our completion program in the first half of the year, you'll see them ramping up starting in Q2 going into Q3 and Q4. So we really expect -- we're going to finish the year strong in 2019 as well as when we go into 2020, we are going to be in really good shape.

Betty Jiang -- Credit Suisse -- Analyst

And then just looking at the standpoint of the spuds that are planned to be done in '19 versus what was done in '18, it looks like there's incremental drilling efficiencies picked up. Can you just talk about kind of what you've seen kind of the back half of maybe '18 versus the first half of '18?

Mark Erickson -- Chairman and Chief Executive Officer

Sure. Matt, do you want to take that?

Matt Owens -- Co-Founder and President

Yes, in terms of well costs, is that what you're implying?

Betty Jiang -- Credit Suisse -- Analyst

In terms of well costs, but also the same (inaudible) spud-to-TD days.

Matt Owens -- Co-Founder and President

Yes. Our spud-to-TD days have -- they've always been extremely quick. They continue to get better. Our averages continue to come down. That's just the new pace that we're at right now with running pretty much two rigs full-time for the 2019 calendar year. And then as far as the well costs go, we haven't really baked any significant cost decreases into our AFEs. We still are budgeting off the ones in the appendix of our presentation, but we are working with our vendors right now, given the dip in oil prices that we've had for the last few months and seeing what major ticket items we can get a little bit relief on going forward throughout the rest of the year.

Betty Jiang -- Credit Suisse -- Analyst

Great, thank you.

Operator

Our next question comes from the line of John Nelson with Goldman Sachs. Your line is now open.

John Nelson -- Goldman Sachs -- Analyst

Good morning and congratulations on the very strong quarter.

Mark Erickson -- Chairman and Chief Executive Officer

Thank you, John.

John Nelson -- Goldman Sachs -- Analyst

The budget -- in the release, you guys talk about how the budgets kind of built to be cash flow neutral at $50, looking at a strip that remains kind of above $50 a barrel. Could you speak to what the preference would be to potentially add rigs later in the year, oil prices continue to remain stronger than what you base cased?

Mark Erickson -- Chairman and Chief Executive Officer

Sure, I mean, right now, our desire with any free cash flow is going to be to use it to reduce debt. So, and we've also -- we have an ongoing and open share repurchase program as well as the debt repurchase program, so it's -- we've kind of been looking at each of those different categories opportunistically and kind of targeting our free cash flow probably we could put it to best use.

John Nelson -- Goldman Sachs -- Analyst

Okay. And then on the Rocky Mountain pipeline that you guys have been discussing, are there any MVCs associated with that start-up in 4Q '19?

Mark Erickson -- Chairman and Chief Executive Officer

There are and they are disclosed in the K. When we look at the volumes for the MVC (ph) in order to get that project brought to us, we consider them to be well covered with our Greeley volumes that we're bringing into that system.

John Nelson -- Goldman Sachs -- Analyst

Great. And just last one for me is, roughly $100 million for midstream spend in the neighborhood for 2019, I saw the Hawkeye, I guess subsets slipped in timing a little bit. Not sure if that's still a good neighborhood to be in.

Mark Erickson -- Chairman and Chief Executive Officer

That will be around the $200 million and $250 million number.

John Nelson -- Goldman Sachs -- Analyst

That's for -- but just for 2019.

Mark Erickson -- Chairman and Chief Executive Officer

Yes, just for 2019.

John Nelson -- Goldman Sachs -- Analyst

Okay, thank you.

Operator

Our next question comes from the line of Welles Fitzpatrick with SunTrust. Your line is now open. This question comes from the line of Jacob Gomolinski-Ekel with Morgan Stanley. Your line is now open.

Jacob Gomolinski-Ekel -- Morgan Stanley -- Analyst

Hi, good evening, and thanks for taking the questions. You mentioned in terms of use of excess free cash flow given the budget was based on $50 WTI and we're a little bit higher than that. The -- with the stock sort of at the lows, some of the bonds in call it 70s or low-80s (ph), obviously the -- you mentioned the focus is on reducing debt. How do you balance sort of paying down prepaying RBL versus buying back bonds and you kind of look at -- are you looking at it on capturing discount on the bonds or like a yield play?

Mark Erickson -- Chairman and Chief Executive Officer

So that's kind of how we've looked at it. We've noticed that both our stock and our bonds are -- that it shows up when there is some buying in the market, but we try to balance out when our bonds are trading at a significant discount we really like -- we really like to pick those up and then alternatively our stocks have great value every day right now, and so just in certain windows we've been going ahead and picking it up.

Jacob Gomolinski-Ekel -- Morgan Stanley -- Analyst

Okay, that makes sense. And have you had any additional ongoing -- I apologize if I missed this, but any additional ongoing conversations with DCP in terms of their methodology for allocations? It sounded like there might be some room for discussion based on the most -- on last quarter's call.

Mark Erickson -- Chairman and Chief Executive Officer

We're in discussions with DCP very often as you can imagine, but has -- so as far as our budget goes for what the numbers regarding to in 2019, we didn't assume that there is going to be any change. We just assumed it was status quo to what it was at year-end.

Jacob Gomolinski-Ekel -- Morgan Stanley -- Analyst

Okay. So it's fair to kind of -- it would just -- there's some upside if there is some successful discussions with DCP.

Mark Erickson -- Chairman and Chief Executive Officer

They very well could be, but it's, again it's not something that we're taking into account in our budget.

Jacob Gomolinski-Ekel -- Morgan Stanley -- Analyst

Okay. And then just a last question from me. Do you have any additional detail or thoughts on the building put together by the Colorado House and Senate, at the moment and how that might affect your operations?

Mark Erickson -- Chairman and Chief Executive Officer

We try to stay as abreast of it as we can. But realistically, we really don't know any more information than anybody else does. That's really in the different news clips. We're -- the discussions that we're having with multiple parties, we feel that the outcome is going to be a balanced outcome that is -- hopefully brings both sides of the issue together and allows industry to have a clear path developing going forward.

Jacob Gomolinski-Ekel -- Morgan Stanley -- Analyst

Okay. That make sense. Thank you very much.

Mark Erickson -- Chairman and Chief Executive Officer

Thanks.

Operator

(Operator Instructions) We have a question from the line of Welles Fitzpatrick with SunTrust. Your line is now open. Mr. Fitzpatrick your line may be on mute. I'm showing no further questions in queue at this time.

I'd like to turn the call back to Mark Erickson, for closing remarks.

Mark Erickson -- Chairman and Chief Executive Officer

Sure. I'd just like to thank everybody for participating in our call and really pleased to deliver the strong results we did in Q4. Thank you.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This concludes the program and you may now disconnect. Everyone have a great day.

Duration: 28 minutes

Call participants:

Louis Baltimore -- Director of Investor Relations

Mark Erickson -- Chairman and Chief Executive Officer

Welles Fitzpatrick -- SunTrust -- Analyst

Brad Heffern -- RBC Capital Markets -- Analyst

Paul Grigel -- Macquarie -- Analyst

Matt Owens -- Co-Founder and President

Betty Jiang -- Credit Suisse -- Analyst

Gail Nicholson -- Stephens Inc -- Analyst

John Nelson -- Goldman Sachs -- Analyst

Jacob Gomolinski-Ekel -- Morgan Stanley -- Analyst

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